Monthly Archives: March 2017

By Jonathan C. Lipson (Temple University-Beasley School of Law) and Melissa B. Jacoby (University of North Carolina – Chapel Hill School of Law)

The U.S. Supreme Court decided Czyzewski v. Jevic Holding Corp., in which we coauthored a brief for amici curiae law professors in support of Petitioners, truck drivers whom Jevic terminated shortly before it filed for bankruptcy. Holding about $8.3 million in priority wage claims, these workers objected to a settlement that Jevic’s shareholders and senior lenders reached with the creditors’ committee. The settlement denied the workers their priority payment, dismissed the bankruptcy, and foreclosed the workers’ rights to challenge under state law the leveraged buyout that led to the bankruptcy. The Third Circuit concluded that such a settlement was permissible in “rare” circumstances. The Supreme Court disagreed, holding that structured dismissals must comply with priority rules absent consent of the affected parties.

Justice Breyer’s majority opinion is notable for at least two reasons. First, it recognizes what was ultimately at stake: the integrity and efficiency of the chapter 11 process. The consequences of failing to reverse, the Court explains, “are potentially serious,” and include “risks of collusion,” “making settlement more difficult to achieve,” and eroding procedural protections that “Congress granted particular classes of creditors,” such as unpaid workers. The Court found no basis in bankruptcy law to allow for exceptions to priority rules in “rare” cases, and seemed to doubt that Jevic was such a case in any event.

Second, consider what Justice Breyer’s decision does not do. It does not, contrary to some reports, prohibit all structured dismissals: “We express no view about the legality of structured dismissals in general,” Justice Breyer noted. The decision also distinguishes the impermissible final distribution in Jevic from interim distributions, such as critical vendor orders, which might deviate from bankruptcy’s priority rules temporarily, but serve other fundamental objectives. By contrast, the Court in Jevic could not find “any significant offsetting bankruptcy-related justification.” The opinion also avoided related issues, such as the propriety of “gift plans” or third-party releases. It shows, however, that Justice Breyer may be the best Justice for the job, if or when the Court chooses to tackle those questions.

The Court’s opinion is available here, and our brief is available here.

The Roundtable posted opposing views on Jevic leading up to oral argument in the case see. See Melissa Jacoby & Jonathan Lipson on their amicus brief and Bruce Grohsgal making the case for structured dismissals. For other Roundtable posts related to priority, see Casey & Morrison, “Beyond Options”; Baird, “Priority Matters”; and Roe & Tung, “Breaking Bankruptcy Priority,” an article that was referenced in the Jevic opinion.

This paper examines the intervention of the law, and the role of the court, in debt restructuring, both in terms of imposing constraints on creditors and in seeking to ameliorate the potential abuses that can arise from such constraints. Three potential forms of abuse are examined: the imposition of a restructuring on dissenting creditors, which introduces the potential for wealth transfers between creditors; the imposition of a moratorium while a restructuring is negotiated, which might lead to misuse of the process by managers wishing to prop up companies that are not viable or may allow the managers of a viable business to “shake off” liabilities that the business is capable of servicing; and the imposition of debtor-in-possession arrangements, which raise the potential for new creditors to be preferred at the expense of existing creditors. It is argued that the court’s role in protecting creditors from these three forms of potential abuse is vital, although the nature of that role differs according to the form of abuse. Recent debt restructuring reform proposals in both the UK and the EU, which adopt quite different approaches to the role of the court in this process, are examined in the light of this discussion.

By Aurelio Gurrea-Martínez (Harvard Law School and Ibero-American Institute for Law and Finance)

Most insolvency jurisdictions provide several mechanisms to reverse transactions entered into by a debtor prior to the commencement of the bankruptcy procedure. These mechanisms, generally known as claw-back actions or avoiding powers, fulfill several economic goals. First, they act as an ex post alignment of incentives between factually insolvent debtors and their creditors, since the latter become the residual claimants of an insolvent firm but do not have any formal control over the debtor´s assets while the company is not yet subject to a bankruptcy procedure. Therefore, the existence of these mechanisms allows the prevention or, at least, reversal of opportunistic behaviors by factually insolvent debtors. Second, the existence of avoidance actions may also prevent, at an early stage, a destructive race to collect. Third, these legal devices also minimize the overinvestment problems potentially faced by insolvent debtors. Fourth, the existence of avoidance powers may encourage managers to take corrective actions in a timely manner. Finally, the existence of avoidance actions may also protect the interests of both the debtor and its creditors as a whole when some market participants want to take advantage of a distressed debtor.

However, the use—and even existence—of avoidance actions is not costless. On one hand, such actions bring litigation costs. On the other hand, the existence of these provisions may be harmful for legal certainty, especially in those countries in which bad faith is not required to avoid a transaction and the “twilight period” may be too long.

In a recent paper, I discuss how insolvency legislators should deal with this trade-off. Namely, by providing an economic and comparative analysis of avoidance actions, I discuss the optimal way to design claw-back actions across jurisdictions, taking into account the costs and benefits potentially generated by these provisions.

As more Companies face liquidity issues and near term debt maturities, they are looking closely to exceptions contained within their indenture/credit agreement covenants in order to achieve an overall or partial restructuring of their capital structure. Investments in “Unrestricted Subsidiaries” are an exception to investment covenants, which have been used in an attempt to provide flexibility in restructuring a Company’s capital structure. Before purchasing debt, distressed investors need to be mindful of what Unrestricted Subsidiaries are and how they impact the overall credit of a Company or debt recovery.

Companies may use Unrestricted Subsidiaries in order to transfer a valuable asset outside of the purview of a Financing Agreement’s covenants. A Company can use the Unrestricted Subsidiary to exchange near term maturing debt junior in the Company’s capital structure for debt issued by the Unrestricted Subsidiary – an exchange that would otherwise not be permitted by the covenants. The exchanged indebtedness could then be supported by the asset which has been transferred to the Unrestricted Subsidiary.

Two recent and well publicized examples of moving value into an Unrestricted Subsidiary are iHeartCommunications (“iHeart”) and J.Crew Group, Inc. (“J.Crew”). In iHeart, the stock of an iHeart subsidiary was moved to an Unrestricted Subsidiary in order to effect a debt exchange, while in J.Crew valuable intellectual property was moved into an Unrestricted Subsidiary for likely the same purpose. Investors must be prepared to determine if there is a way for a Company to utilize its covenants to transfer value to an Unrestricted Subsidiary.

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During the past century, three decisionmaking systems have arisen to accomplish a bankruptcy restructuring — judicial administration, a deal among the firm’s dominant players, and a sale of the firm’s operations in their entirety. Each is embedded in the Bankruptcy Code today, with all having been in play for more than a century and with each having had its heyday — its dominant age. The shifts, rises, and falls among decisionmaking systems have previously been explained by successful evolution in bankruptcy thinking, by the happenstance of the interests and views of lawyers that designed bankruptcy changes, and by the interests of those who influenced decisionmakers. Here I argue that these broad changes also stem from baseline market capacities, which shifted greatly over the past century; I build the case for shifts underlying market conditions being a major explanation for the shifts in decisionmaking modes. Keeping these three alternative decisionmaking types clearly in mind not only leads to better understanding of what bankruptcy can and cannot do, but also facilitates stronger policy decisions today here and in the world’s differing bankruptcy systems, as some tasks are best left to the market, others are best handled by the courts, and still others can be left to the inside parties to resolve.

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About the Roundtable

The Harvard Law School Bankruptcy Roundtable promotes dissemination of academic and practitioner views of current bankruptcy issues, via weekly posts targeting issues of interest, typically linking to a more extended analysis elsewhere. For inquiries and comments, please contact us at bankruptcyproject@law.harvard.edu.